Bonds and Gold in Unusual Correlation

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Gold prices have shown an unusually strong correlation to bond prices this year. This is not normal, and the two are not usually marching in lockstep like this.

The strong correlation began around May 2016. It may just be a coincidence that May 2016 was when Saudi Arabia started selling off the holdings of T-Bonds from its sovereign wealth fund, an effort to fund their governmental expenditures in an era of low profits on oil sales. See http://ticdata.treasury.gov/Publish/mfh.txt.

Whatever the explanation is, the phenomenon is real, down to even a day to day basis. So if you are a trader or investor who is interested in gold, you had better also be interested in T-Bonds, at least for as long as this correlation lasts.

It is not a normal correlation that we are seeing right now. Here is a longer term chart, which shows that while there may occasionally be some coincident price turns, the two plots are not generally well-correlated. Often they move inversely, which makes more sense since gold is supposed to benefit from higher inflation, while bonds get hurt by it.

So what lies ahead for bonds and gold? If you believe the big money (smart money) “commercial” traders of T-Bond futures, there should be a big rebound coming.

Back in July 2016, these smart money traders were holding an all-time record net short position in T-Bond futures. They correctly anticipated the big price decline which unfolded. Along the way, they have unwound those shorts, and now they are at a multi-year extreme net long position, betting on a big rebound.

That presumptive rebound should also lift gold prices, assuming that the correlation continues. And as I discussed back in August, that should also presumably bring a rebound for the Japanese yen.